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CHAPTER THREE

Cola Wars: Coca-Cola vs. PepsiCo

ntense competition between Pepsi and Coca-Cola has characterized the soft-drink industry for decades. In this chess game of giant rms, Coca-Cola ruled the soft-drink market throughout the 1950s, 1960s, and early 1970s. It outsold Pepsi two to one. But this was to change. Then the chess game, or war, switched to the international arena, and it became a world war.

EARLY BATTLES, LEADING TO NEW COKE FIASCO

Pepsi Inroads, 1970s and 1980s
By the mid-1970s, the Coca-Cola Company was a lumbering giant. Performance reected this. Between 1976 and 1978, the growth rate of Coca-Cola soft drinks dropped from 13 percent annually to a meager 2 percent. As the giant stumbled, Pepsi Cola was nding heady triumphs. First came the Pepsi Generation. This advertising campaign captured the imagination of the baby boomers with its idealism and youth. This association with youth and vitality greatly enhanced the image of Pepsi and rmly associated it with the largest consumer market for soft drinks. Then came another management coup, the Pepsi Challenge, in which comparative taste tests with consumers showed a clear preference for Pepsi. This campaign led to a rapid increase in Pepsis market share, from 6 to 14 percent of total U.S. soft-drink sales. Coca-Cola, in defense, conducted its own taste tests. Alas, these tests had the same resultpeople liked the taste of Pepsi better, and market-share changes reected this. As Table 3.1 shows, by 1979, Pepsi was closing the gap on Coca-Cola, having 17.9 percent of the soft-drink market, to Cokes 23.9 percent. By the end of 1984, Coke had only a 2.9 percent lead, while in the grocery store market it was now trailing by 1.7 percent. Further indication of the diminishing position of Coke relative to Pepsi was a study done by Coca-Colas own marketing research department. The study showed that in 1972, 18 percent of soft-drink users drank Coke exclusively, while only 4 percent drank only Pepsi. In 10 years the picture had changed greatly: 31

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32 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo TABLE 3.1 Coke and Pepsi Shares of Total Soft-Drink Market, 1950s1984
1975 Mid-1950s Lead Coke Pepsi Better than 2 to 1 % of Market 24.2 17.4 Lead 6.8 1979 % of Market 23.9 17.9 Lead 6.0 1984 % of Market Lead 21.7 18.8 2.9

Source: Thomas Oliver, The Real Coke. The Real Story (New York: Random House, 1986), pp. 21, 50; Two Cokes Really Are Better Than OneFor Now, Business Week, 9 September 1985, p. 38.

Only 12 percent now claimed loyalty to Coke, while the number of exclusive Pepsi drinkers almost matched, with 11 percent. Figure 3.1 shows this change graphically. What made the deteriorating comparative performance of Coke all the more worrisome and frustrating to Coca-Cola was that it was outspending Pepsi in advertising by $100 million. It had twice as many vending machines, dominated fountains, had more shelf space, and was competitively priced. Why was it losing market share? The advertising undoubtedly was not as effective as that of Pepsi, despite vastly more money spent. And this raises the question: How can we measure the effectiveness of advertising? See the following Information Box for a discussion.

Coca-Cola Tries to Battle Back

The Changing of the Guard at Coke J. Paul Austin, chairman of Coca-Cola, was nearing retirement in 1980. Donald Keough, president for the American group, was expected to succeed him. But a new name, Roberto Goizueta, suddenly emerged. Goizuetas background was far different

Figure 3.1 Coke versus Pepsi: Comparison of exclusive drinkers, 1972 and 1982.

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Early Battles, Leading to New Coke Fiasco 33

INFORMATION BOX HOW DO WE MEASURE THE EFFECTIVENESS OF ADVERTISING?

A rm can spend millions of dollars for advertising, and it is only natural to want some feedback on the results of such an expenditure: To what extent did the advertising really pay off? Yet many problems confront the rm trying to measure this. Most methods for measuring effectiveness focus not on sales changes, but on how well the communication is remembered, recognized, or recalled. Most evaluative methods simply tell which ad is the best among those being appraised. But even though one ad may be found to be more memorable or to create more attention than another, that fact alone gives no assurance of relationship to sales success. A classic example of the dire consequences that can befall advertising people as a result of the inability to directly measure the impact of ads on sales occurred in December 1970. In 1970, the Doyle Dane Bernbach advertising agency created memorable TV commercials for Alka-Seltzer, such as the spicy meatball man, and the poached oyster bride. These won professional awards as the best commercials of the year and received high marks for humor and audience recall. But in December, the $22 million account was abruptly switched to another agency. The reason? Alka-Seltzers sales had dropped somewhat. Of course, no one will ever know whether the drop might have been much worse without these notable commercials. So, how do we measure the value of millions of dollars spent for advertising? Not well; nor can we determine what is the right amount to spend, what is too much, or too little. Can a business succeed without advertising? Why or why not?

from that of the typical Coca-Cola executive. He was not from Georgia (the company is headquartered in Atlanta) and was not even southern. Rather, he was the son of a wealthy Havana sugar plantation owner. He came to the United States at age sixteen, speaking virtually no English. By using the dictionary and watching movies, he quickly learned the language and graduated from Yale in 1955 with a degree in chemical engineering. Returning to Cuba, he went to work in Cokes Cuban research lab. Goizuetas complacent life was to change in 1959 when Fidel Castro seized power. With his wife and three children he ed to the United States, arriving with $20. At Coca-Cola, he became known as a brilliant administrator and in 1968 was brought to company headquarters; he became chairman of the board thirteen years later, in 1981. Donald Keough had to settle for being president. In the new era of change, the sacredness of the commitment to the original Coke formula became tenuous, and the ground was laid for the rst avor change in ninetynine years. Introducing a New Flavor for Coke With the market-share erosion of the late 1970s and early 1980s, despite strong advertising and superior distribution, the company began to look at the soft-drink product itself. Taste was suspected as the chief culprit in Cokes decline, and marketing

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34 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo research seemed to conrm this. In September 1984, the technical division developed a sweeter avor. In perhaps the biggest taste test ever, costing $4 million, 55 percent of 191,000 people approved it over Pepsi and the original formula of Coke. Top executives unanimously agreed to change the taste and take the old Coke off the market. But the results abbergasted company executives. While some protests were expected, they quickly mushroomed; by mid-May 1985 calls were coming in at the rate of 5,000 a day, in addition to a barrage of angry letters. People were speaking of Coke as an American symbol and as a long-time friend who had suddenly betrayed them. Anger spread across the country, fueled by media publicity. Fiddling with the formula for the 99-year-old beverage became an affront to patriotic pride. Even Goizuetas father spoke out against the switch and jokingly threatened to disown his son. By now the company began to worry about a consumer boycott against the product. On July 11th company ofcials capitulated to the outcry. They apologized to the public and brought back the original taste of Coke. Roger Enrico, president of Pepsi-Cola, USA, gloated, Clearly this is the Edsel of the 80s. This was a terrible mistake. Cokes got a lemon on its hand and now theyre trying to make lemonade. Other critics labeled this the marketing blunder of the decade.1 Unfortunately for Pepsi, the euphoria of a major blunder by Coca-Cola was short lived. The two-cola strategy of Coca-Colait kept the new avor in addition to bringing back the old classicseemed to be stimulating sales far more than ever expected. While Coke Classic was outselling New Coke by better than two to one nationwide, for the full year of 1985, sales from all operations rose 10 percent and prots 9 percent. Coca-Colas fortunes continued to improve steadily. By 1988, it was producing ve of the top-ten selling soft drinks in the country and now had a total 40 percent of the domestic market to 31 percent for Pepsi.2

BATTLE SHIFTS TO INTERNATIONAL ARENA

Pepsis Troubles in Brazil
Early in 1994, PepsiCo began an ambitious assault on the soft-drink market in Brazil. Making this invasion even more tempting was the opportunity to combat arch-rival Coca-Cola, already entrenched in this third largest soft-drink market in the world, behind only the United States and Mexico. The robust market of Brazil had attracted Pepsi before. Its hot weather and a growing teen population positioned Brazil to become one of the worlds fastest-growing soft-drink markets, along with China, India, and Southeast Asia. But the potential still had barely been tapped. Brazilian consumers averaged only 264 eight-ounce servings of soft drinks a year, far below the U. S. average of about 800.3
1 2

John Greenwald, Coca-Colas Big Fizzle, Time, July 22, 1985, pp. 4849. Some Things Dont Go Better with Coke, Forbes, March 21, 1988, pp. 3435. 3 Robert Frank and Jonathan Friedland, How Pepsis Charge into Brazil Fell Short of Its Ambitious Goals, Wall Street Journal, August 30, 1996, p. A1.

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Battle Shifts to International Arena 35

Three times during the previous twenty-ve years, Pepsi had attempted to enter the Brazilian market with splashy promotional campaigns and different bottlers. Each of these efforts proved disappointing, and Pepsi quickly dropped them and retreated from the eld. In 1994, it planned a much more aggressive and enduring push. A Super Bottler, Baesa, and Charles Beach Buenos Aires Embotelladora SA, or Baesa, was to be the key to Pepsis rejuvenated entry into Brazil. Baesa would be Pepsis superbottler, one that would buy small bottlers across Latin America, expand their marketing and distribution, and be the fulcrum in the drive against Coca-Cola. Charles Beach, the CEO of Baesa, was the person around whom Pepsi planned its strategy. Beach, 61, was a passionate, driven man, a veteran of the cola wars, but his was a checkered past. A Coca-Cola bottler in Virginia, he was indicted by a federal grand jury on charges of price xing and received a $100,000 ne and a suspended prison sentence. He then bought Pepsis small Puerto Rican franchise in 1987. Then, in 1989, Beach acquired the exclusive Pepsi franchise for Buenos Aires, Argentina one of the most important bottling franchises outside the United States. By discounting and launching new products and packages, he caught Coke by surprise. In only three years, he had increased Pepsis market share in the Buenos Aires metro area from almost zero to 34 percent.4 With Pepsis blessing, Beach expanded vigorously, borrowing heavily to do so. He bought major Pepsi franchises in Chile, Uruguay, and most importantly, Brazil, where he built four giant bottling plants. Pepsi worked closely with Baesas expansion, providing funds to facilitate it. However, they underestimated the aggressiveness of Coca-Cola. Their rival spent heavily on marketing and cold-drink equipment for its choice customers. As a result Baesa was shut out of small retail outlets, those most protable for bottlers. Goizueta, CEO of Coca-Cola, used his Latin American background to inuence the Argentine president to reduce an onerous 24 percent tax on cola to 4 percent. This move strengthened Cokes position against Baesa, which in contrast to Coca-Cola was earning most of its prots from non-cola drinks. By early 1996, Baesas expansion plansand Pepsis dreamwere oundering. The new Brazilian plants were running at only a third of capacity. Baesa lost $300 million for the rst half of 1996, and PepsiCo injected another $40 million into Baesa. On May 9, Beach was relieved of his position. Allegations now surfaced that Beach might have tampered with Baesas books.5 But PepsiCos troubles did not end with the debacle in Brazil.

Intrigue in Venezuela
Brazil was only symptomatic of other overseas problems for Pepsi. Roger Enrico, now CEO, had reasons to shake his head and wonder at how the gods seemed against him.

4 5

Patrica Sellers, How Coke Is Kicking Pepsis Can, Fortune, October 28, 1996, p. 78. Ibid, p. 79.

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36 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo But it was not the gods, it was Coca-Cola. Enrico had been on Cokes blacklist since he had gloated a decade before about the New Coke debacle in his memoir, The Other Guy Blinked: How Pepsi Won the Cola Wars. Goizueta was soon to gloat, It appears that the company that claimed to have won the cola wars is now raising the white ag.6 The person Enrico thought was his close friend, Oswaldo Cisneros, head of one of Pepsis oldest and largest foreign bottling franchises, suddenly abandoned Pepsi for Coca-Cola. Essentially, this took Pepsi out of the Venezuelan market. Despite close ties of the Cisneroses with the Enricos, little things led to the chasm. The closeness had developed when Enrico headed the international operations of PepsiCo. After Enrico left this position for higher ofces at corporate headquarters, Oswaldo Cisneros felt that Pepsi management paid scant attention to Venezuela: That showed I wasnt an important player in their future, he said.7 Because Cisneros was growing older, he wanted to sell the bottling operation, but Pepsi was only willing to acquire 10 percent. Coca-Cola wooed the Cisneroses with red-carpet treatment and frequent meetings with its highest executives. Eventually, Coca-Cola agreed to pay an estimated $500 million to buy 50 percent of the business.

Pepsis Problems Elsewhere in the International Arena

Pepsis problems in South America mirrored its problems worldwide. It had lost its initial lead in Russia, Eastern Europe, and parts of Southeast Asia. While it had a head start in India, this was being eroded by a hard-driving Coca-Cola. Even in Mexico, its main bottler reported a loss of $15 million in 1995. The contrast with Coca-Cola was signicant. Pepsi still generated more than 70 percent of its beverage prots from the United States; Coca-Cola got 80 percent from overseas.8 Table 3.2 shows the top-ten markets for Coke and Pepsi in 1996 in the total world market. Coke had a 49 percent market share while Pepsi had only 17 percent, despite its investment of more than $2 billion since 1990 to straighten out its overseas bottling operations and improve its image.9 With its careful investment in bottlers and increased nancial resources to plow into marketing, Coke continued to gain greater control of the global soft-drink industry. If there was any consolation for PepsiCo, it was that its overseas business had always been far less important to it than to Coca-Cola, but this was slim comfort in view of the huge potential this market represented. Most of Pepsis revenues were in the U. S. beverage, snack food, and restaurant businesses, with such well-known brands as Frito-Lay, Taco Bell, Pizza Hut, and KFC (Kentucky Fried Chicken) restaurants. But as a former Pepsi CEO was fond of stating, Were proud of the U. S.
6 7

Ibid, p. 72. Ibid, p. 75. 8 Frank and Friedland, p. A1. 9 Robert Frank, Pepsi Losing Overseas Fizz to Coca-Cola, Wall Street Journal, August 22, 1996, p. C2.

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Coke Travails in Europe, 1999 37

TABLE 3.2 Coke and Pepsi Shares of Total Soft-Drink Sales, Top Ten Markets, 1996
Market Shares Markets United States Mexico Japan Brazil East-Central Europe Germany Canada Middle East China Britain Coke 42% 61 34 51 40 56 37 23 20 32 Pepsi 31% 21 5 10 21 5 34 38 10 12

Source: Company annual reports, and Patricia Sellers, How Coke Is Kicking Pepsis Can, Fortune, 28 October 1996, p. 82. Commentary: These market share comparisons show the extent of Pepsis ineptitude in its international markets. In only one of these top 10 overseas markets is it ahead of Coke, and in some, such as Japan, Germany, and Brazil, it is practically a nonplayer.

business. But 95 percent of the world doesnt live here.10 And Pepsi seemed unable to hold its own against Coke in this world market.

COKE TRAVAILS IN EUROPE, 1999

The Trials of Douglas Ivester
In early 1998, Douglas Ivester took over as chairman and chief executive of CocaCola. He had a tough act to follow, being the successor to the legendary Goizuerta. Things seemed to go downhill from then on, but it was not entirely his fault. The rst quarter of 1999 witnessed a sharp slowdown in Coca-Colas North American business, at least partly due to price increases designed to overcome weakness resulting from overseas economic woes. While most analysts thought the sticker shock of higher prices would be temporary, some thought the company needed to be more innovative, needed to do more than offer super-size drinks.11 Other problems emanated from a racial discrimination lawsuit, as well as Mr. Ivesters brassy

10 11

Frank, p. C2. Nikhil Deogun, Cokes Slower Sales Are Blamed on Price Increases, Wall Street Journal, March 31, 1999, pp. A3, A4.

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38 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo attempts to make acquisitions such as Orangina and Cadbury Schweppes, angering overseas regulators and perhaps motivating them to make life difcult for Coca-Cola. Such concerns paled before what was to come. Contamination Scares On June 8th, a few dozen Belgian schoolchildren began throwing up after drinking Cokes. This was to result in one of the most serious crises in Coca-Colas 113-year history. An early warning had seemingly been ignored when in mid-May the owner of a pub near Antwerp complained of four people becoming sick from drinking badsmelling Coke. The company claimed to have investigated but found no problems. The contamination news could not have hit at a worse time. Belgium was still reeling from a dioxin-contamination food scare in Belgian poultry and other foods, and European agencies were coming under re for a breakdown in their watchdog responsibilities. Ofcials were inclined to be overzealous in their dealings with this big U. S. rm. The problems worsened. Coca-Cola ofcials were meeting with Belgiums health minister, seeking to placate him, telling him that their analyses show that it is about a deviation in taste and color that might cause headaches and other symptoms but does not threaten the health of your child. In the middle of this meeting, news came that another fteen students at another school had gotten sick.12 It was thought that the contamination came from bottling plants in Antwerp, Ghent, and Dunkirk that produced cans for the Belgium market. European newspapers were speculating that Coke cans were contaminated with rat poison. Soon hundreds of sick people in France were blaming their illnesses on Coke, and France banned products from the Dunkirk plant. France and Belgium rebuffed Coca-Colas urgent efforts to lift the ban and scolded the company for not supplying enough information as to the cause of the problem. The setback left Coke out of the market in parts of Europe because the company had badly underestimated how much explanation governments would demand before letting it back in business. Not until June 17 did Belgium and France lift restrictions, and then only on some products; the bans were continued on Coca-Colas Coke, Sprite, and Fanta. Then the Netherlands, Luxembourg, and Switzerland also imposed selective bans until health risks could be evaluated. Some 14 million cases of Coke products eventually were recalled in the ve countries, and estimates were that Coke was losing $3.4 million per day in revenues. Case volume for the European division was expected to fall 6 to 7 percent from the year earlier.13 The peak soft-drink summer season had arrived, and the timing of the scare could not have been worse. The European Union requested further study as the health scare spread. At the same time, Coca-Cola and its local distributors launched an advertising campaign
Anatomy of a Recall: How Cokes Controls Fizzled Out in Europe, Wall Street Journal, June 29, 1999, p. A6. 13 Will Edwards, Coke Chairman Tries to Assure Europeans, Cleveland Plain Dealer, June 19, 1999, pp. C1, C3; and Nikhil Deogun, Coke Estimates European Volume Plunged 6% to 7% in 2nd Quarter, Wall Street Journal, July 1, 1999, p. A4.
12

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Coke Travails in Europe 39

defending the quality of their products. The company blamed defective carbon dioxide, used for zz, for problems at Antwerp. It also said the outsides of cans made in Dunkirk were contaminated with a wood preservative during shipping. One company-commissioned study suggested that health problems were in the victims heads. Meanwhile, the Ivory Coast seized 50,000 cans of Coke imported from Europe as a precautionary measure, though there was no evidence that anyone in the Ivory Coast had become ill by drinking imported Coke. Problems continued to spread. All glass bottles of Bonaqua, a bottled water brand of Coca-Cola, were recalled in Poland because about 1,500 bottles were found to contain mold. This recall in Poland soon spread to glass bottles of Coke. Company ofcials believed the mold was caused by inadequate washing of returnable bottles. Barely a week later, the company recalled 180,000 plastic bottles of Bonaqua after discovering nonhazardous bacteria. Coca-Cola also had to recall some soft drinks in Portugal after small bits of charcoal from a ltration system were found in some cans. Coca-Cola Finally Acts Aggressively In the initial contamination episodes, Coca-Cola was accused of dragging its feet. Part of the problem in ameliorating the situation was the absence of an explanation by any top Coca-Cola ofcials. Ivester was criticized for this delay when he nally made an appearance in Brussels on June 18, ten days after the initial scare. He visited Brussels again four days later, meeting with the prime minister. Strenuous efforts to improve the companys image and public relations then began. Ivester, in a major advertising campaign, apologized to Belgian consumers and explained how the company allowed two breakdowns to occur. The ads showed his photograph along with these opening remarks, My apologies to the consumers of Belgium; I should have spoken with you earlier. Ivester further promised to buy every Belgian household a Coke. A special consumer hotline was established, and fty ofcials including several top executives were temporarily shifted from the Atlanta headquarters to Brussels. Five thousand delivery people then fanned out across the country, offering a free 1.5-liter bottle of Cokes main brands to 4.37 million households. Around Belgium, Coke trucks and displays proclaimed, Your Coca-Cola is coming back. In newspaper ads, the company explained its problems, noted it was destroying old products and using fresh ingredients for new drinks. A similar marketing strategy was planned for Poland, where 2 million free beverages were distributed to consumers.

Pepsis Competitive Maneuvers Near the Millennium

Pepsis Role in Cokes European Problems Some thought that Coca-Colas problems should have been Pepsis gain. Yet Pepsi did nothing to capitalize on the situation, did not gloat, and did not increase advertising for its brand. Worldwide, Pepsi experienced some temporary gains in sales, most surprisingly in countries far removed from the scaresuch as China. A Pepsi bottler in Eastern Europe probably expressed the prevailing company attitude when he observed that people were buying bottled water and juices, instead of soda pop:

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40 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo Thats why we dont wish this stuff on anyone, he said, referring to the health scare.14 But Pepsi was not idle in Europe. Pepsis Antitrust Initiatives Against Coca-Cola In late July 1999, European Union ofcials raided ofces of Coca-Cola and its bottlers in four countries in EuropeGermany, Austria, Denmark, and Britainon suspicions that the company used its dominant market position to shut out competitors. Coming at a time when Coca-Cola was still trying to recover from the contamination problems, this was a cruel blow. All the more so since such alleged noncompetitive activities affected its plans to acquire some additional businesses in Europe. The raids were expected to lead to a full-blown antitrust action against Coke. The major suspicion was that Coke was illegally using rebates to enhance its market share. The several types of rebates under investigation were rebates on sales that boosted Cokes market share at the expense of rivals, and rebates given to distributors who agreed to sell the full range of Coke products or to stop buying from competitors. Coca-Colas huge market share in most countries of Europe fed the concern. See Table 3.3 for Cokes market shares of the total soft-drink market in selected countries in Europe. While the market share of Coke was being scrutinized by European antitrust ofcials, the investigation was sparked by a complaintled by Pepsithat Coke was illegally trying to force competitors out of the market. Pepsi also led a complaint with Italian regulators, and they were quicker to act. A preliminary report found that Coca-Cola and its bottlers violated antitrust laws by

TABLE 3.3 Coca-Colas Market Share of Soft-Drink Market in Selected European Countries, 1998
France Spain Germany Central Europe Italy Nordic and Northern Eurasia Great Britain 59% 58 55 47 45 41 35

Source: Company published reports. Commentary: The dominance of Coke in almost all countries of Europe, not surprisingly, makes it vulnerable to antitrust scrutiny.

14

Nikhil Deogun and James R. Hagerty, Coke Scandal Could Boost Rivals, But Also Could Hurt Soft Drinks, Wall Street Journal, June 23, 1999, p. A4.

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Coke Finds Tough Going in New Century While Pepsi Surges 41

abusing a dominant market position through practices such as discounts, bonuses, and exclusive deals with wholesalers and retailers. The Italian regulators also said there was evidence that Coke had a strategic plan to remove Pepsi from the Italian market, one of the biggest in Europe, by paying wholesalers to remove Pepsi fountain equipment and replace it with Coke. At about this time, Australian and Chilean ofcials also began conducting informal inquiries in their markets. Coca-Cola ofcials responded to the Italian report as follows: We believe this is a baseless allegation by Pepsi and we believe that Pepsis poor performance in Italy is due to their lack of commitment and investment there. As a result, they are attempting to compete with us in the courtroom instead of the marketplace.15

COKE FINDS TOUGH GOING IN NEW CENTURY WHILE PEPSI SURGES

For decades, Coca-Cola was a premier growth company with some of the best-known brands in the world, and management seemed well positioned to take advantage of the global economy. But we have just seen lapses in the late 1990s, particularly in handling contamination problems in Europe and in dealing with antitrust charges there. Going into the new century, the new millennium, problems seemed more subtle but with longer lasting concerns. Not that the old esteemed company was withering away, but rather that it faced a slowing growth trend. For example, Coke generated average annual earnings growth of 18 percent between 1990 and 1997. In recent years, its net income grew at just a 4 percent average. Share prices had fallen hard, in 2004 trading at less than half their 1998 peak. At the same time, PepsiCo, while it never quite caught Coke in the cola wars, outdid its rival in overall business growth. The following comparative statistics show the slipping performance of Coca-Cola to PepsiCo over the ve years to 2004.
Coke Sales 2003 Sales growth (5-year average) Earnings Earnings growth (5-year average) Stock price (5 years ending 12/3/04) $21 billion 2% $4.3 billion 4% 40% Pepsi $27 billion 4% $3.6 billion 12% 38%

Source: Bloomberg Financial Markets as reported in Dean Foust, Gone Flat, Business Week, December 20, 2004, p. 82.

Part of the problem facing Coke was an industry problem, but with its heavy emphasis on carbonated soft drinks, it became worse for Coke than for Pepsi. Consumers, more concerned with health and obesity, were seeking new kinds of

15

Betsy McKay, Coke, Bottlers Violated Antitrust Laws in Italy, a Preliminary Report States, Wall Street Journal, August 13, 1999, p. A4.

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42 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo beverages such as gourmet coffees, New Age teas, sports drinks, and waters. Carbonated beverages were no longer a growth sector of the market. One consultant said, The carbonated soft-drink model is 30 years old and out of date.16 Pepsi had pushed into the noncarb market with Tropicana juice, Gatorade sports drink, and Aquana water, and these were billion-dollar beverage brands. Coca-Cola remained xated on its agship Coke brand, with sodas accounting for 82 percent of its worldwide beverage sales, far more than Pepsi. On the other hand, Pepsi not only had more strongly diversied into other non-carb beverages but also had its Frito-Lay Division with snack foods such as Lays, Doritos, and Baked Crunchy Cheetos; and then there was Quaker Oats that it acquired August 2001. (In 1997, PepsiCo had spun off its restaurant operations.) The following shows the breakdown of sales and prots for Pepsis four major businesses as of 2004:
Percentage of Company Sales and Operating Prots Frito-Lay PepsiCo Beverages Quaker Foods PepsiCo Intl. (snacks and beverages)
Source: Public information as of 2004

34 29 5 32

41 30 9 20

Cokes Reluctance to Diversify

Critics blamed Cokes stubborn commitment to its four hallowed soda-pop brands Coca-Cola, Diet Coke, Sprite, and Fantaas going back to the sixteen-year reign of Roberto Goizueta, who guided Coke stock to a 3,500 percent gain in those years. Goizueta was the rst CEO ever to break the $1 billion compensation barrier. After he died of lung cancer in 1997, he was almost deied, and his cola-centric philosophy became the gospel of the executives who followed and also of the aging board of directors. The reluctance to diversify was evident when Coca-Cola decided against acquiring South Beach Beverage Company after negotiating two years. Pepsi made an offer and in weeks acquired the SoBe brand New Age juice company, which gave Pepsi access to a market completely bypassed by soda pop. Neville Isdell came out of retirement to head the company in May 2004, after earlier building distribution networks in India, Russia, and Eastern Europe. He showed the same conservative mindset of his predecessors and passed on the chance to acquire Red Bull, a promising energy drink. Isdell still believed in the growth potential of carbonated soft drinks and their 30 percent prot margins. Because of this conservatism, Coke now lacked a popular entry in the highly protable energy-drink category to compete with what had become the market leader, Red Bull. Some analysts saw this reluctance to diver-

16 Tom Pirko, president of Bev Mark LLC, as quoted in Dean Foust, Gone Flat, Business Week, December 20, 2004, p. 76.

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Coke Finds Tough Going in New Century While Pepsi Surges 43

sify as reecting a corporate mind-set that still saw Coca-Cola as only a soda company, while Pepsi viewed itself as a beverage-and-snack company.17 Still, Coke had joined Pepsi and other rms in moving into bottled water by 2003, as this became the fastest growing sector of the beverage industry. Pepsis Aquana became the leading brand and was enhanced by a multimillion-dollar promotional campaign, while Coke, through acquisitions, amassed such brands as Dannon, Evian, and Dasani. However, Coke was less aggressive than its competitors in pursuing this market, and problems with Dasani further cooled the enthusiasm.

Other Problems
Ivester, CEO successor to Goizueta in the late 90s, in a desperate effort to try to sustain the protability of the Goizueta era, imposed a 7.6 percent price hike on the concentrate it sold its bottlers. For decades, Coke had sold its beverage concentrate to U.S. bottlers at a constant price, no matter what price the soft drinks would later command at retail. Not surprisingly, these bottlers were now incensed and complained bitterly to the board and succeeded in pushing the already embattled Ivester to resign in late 1999. His successor, Douglas Daft, tried to work with them, but relations steadily deteriorated. Bottlers began ghting back with sharp increases in their retail prices of Coke. These hikes dampened sales of Coke but increased bottlers prots. Some also refused to carry the companys new noncarbonated niche offerings, Mad River teas and Planet Java coffee; these opped, and the company phased them out in 2003. Going into 2005, Isdell faced contentious bottler relations that needed to be addressed. The C2 Disappointment In the summer of 2003, Coca-Cola launched C2, a reduced-calorie, reduced-carb cola, with a $50 million promotional campaign. This was Cokes biggest product introduction since Diet Coke more than twenty years before. The company had expected this new beverage would help win back a critical consumer group20- to 40-yearolds who were concerned about weightand priced it at a 15 percent premium in the quest to achieve higher prots on its drinks. But sales of C2 fell nearly 60 percent a few weeks after the product introduction. Isdell halted the premium pricing strategy to try to salvage the product, but still sales languished. The pricing strategy had been botched, as C2 at times retailed for 50 percent and more than regular Coke, especially on weekends when sodas were often discounted. Adding to the dissatisfaction with the higher prices, many consumers were critical of the taste, either too at or with an aftertaste. Advertising Miscues Spending for advertising had become conservative during the reign of Ivester. He believed that the Coke brand could largely sell itself without a major commitment to

17

Foust, p. 80; Leslie Chang, Chad Terhune, and Betsy McKay, Cokes Big Gamble in Asia, Wall Street Journal, August 11, 2004, pp. A1, A6; Behind Cokes CEO Travails: A Long Struggle Over Strategy, Wall Street Journal, May 4, 2004, pp. A1, A10.

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44 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo advertising. The result of a reduced ad budget was lackluster ads that failed to attract the important youth market. Instead, Ivester shifted resources into more vending machines, refrigerated coolers, and delivery trucksgrowth through distribution. But some of these expanded distribution sites, such as auto part stores, did not pay off. Global Problems Even Cokes global strength was becoming tarnished. Ivesters slowness in responding to the contamination scare in Belgium and France in 1999 was but the rst misstep. Cokes plans to make Dasani bottled water into a global brand were slowed by an aborted launch in Europe after elevated levels of bromate, a cancer-causing substance, were detected in bottles in Britain. Declining sales in Germany and Mexico, two very important markets, put more pressure on developing such markets as China and India. Yet these looked years away from contributing signicantly to Cokes protability. The distribution and capacity that Isdell built in Eastern Europe in the 1980s and 1990s proved to be extravagant, and write downs eventually exceeded $1 billion.18 Meantime, Pepsi was nibbling away at Cokes international markets. Its antitrust case against Coke in the European Union was eventually settled years later, in October 2004, with Coke having to drop its controversial incentive discounts to retailers, and agreeing to share display space with rivals such as PepsiCo. So, the playing eld was more leveled to Pepsis benet.

Cokes Board of Directors

Few rms could boast as prestigious a board of directors as Coke. Warren Buffett, one of the worlds richest and most inuential investors, was a major presence on the board. Ten of the 14 directors dated back to the Goizueta era and still espoused his policies of concentrating on the basic core of carbonated soft drinks with less emphasis on diversifying. Critics of the board accused it of micromanaging and being too conservative and blamed it for the difculty in recruiting highly regarded candidates for top management jobs and not retaining the ones it had.19 The board played a major part in vetoing the acquisition of Quaker Oats, the maker of Gatorade. CEO Douglas Daft had reached an agreement to buy Quaker for $15.75 billion in stock. But the board overruled him, calling the price too expensive. PepsiCo snapped up the company instead. Daft was left to contemplate his lack of support by the board, and his loss of faith among his peers. He tenure was short lived, and Isdell replaced him.

ANALYSIS
Cokes Outlook at the New Millennium
The situation by 2005 did not come about suddenly. It gradually crept up until a deteriorating stock price confronted investors, managers, and analysts. Yet the company

18 19

Terhune and McKay, p. A6. For example, see Dean Foust, pp. 79, 82; and Behind Cokes CEO Travails, pp. A1, A6.

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Analysis 45

was still healthy and protable, but somehow the Coke name had lost its cachet and critics abounded. Then there was PepsiCo becoming more formidable all the time. Proposals for dealing with the situation went to two extremes: (1) stick with the basics and simply do things better, or (2) vigorously diversify, even to non-drink areas as Pepsi had seemingly done successfully. The two approaches could be categorized as a mission of being a soda company versus an expanded mission of being a beverage-and-snack company. Cokes board, hearkening back to the glory days of Goizueta, was negative toward mergers and strongly favored doing a better job with the basic core, such as with advertising, distribution, and tapping international markets more aggressively. Critics, however, saw Coke as too wedded to the status quo and missing growth opportunities. Of course, there is a third option between the two extremes. This would look for suitable diversications within the non-cola drink market, and even fortuitous and compatible non-drink additions, but without any mandate to go on a merger binge. Several factors affect whatever direction the company eventually takes. One is the recent trend toward healthy lifestyles, and the foods and drinks that affect this either negatively or positively. Worrisome omens were appearing. Some schools were removing colas from their vending machines and school lunches. Advertisements and other publicity were trumpeting the health risks of fast foods and soft drinks. Was this the wave of the future, or merely a short-term phenomenon? Then Coke needs to confront whether its days as a growth rm are over and if it is in the mature stage of its life cycle. The long-term consequences of this decision will hardly be inconsequential. In Chapter 2, McDonalds was facing some of the same issues and concerns as Coke. Disavowing aggressive growthrecognizing a mature life cyclecan be benecial to investors, at least in the short run, since more prots are available for dividends. But the search for breakthrough diversications should not be abandoned. The right one(s) might well put a mature rm on the growth path again.

What Went Wrong with the New Coke Decision?

The most convenient scapegoat was the marketing research that preceded the decision. Yet Coca-Cola spent about $4 million and devoted two years to the marketing research. About 200,000 consumers were contacted during this time. The error in judgment was surely not from want of trying. But when we dig deeper into the research, some aws become apparent. Flawed Marketing Research The major design of the marketing research involved taste tests by representative consumers. After all, the decision point was whether to go with a different-avored Coke, so what could be more logical than to conduct taste tests to determine acceptability of the new avor, not only versus the old Coke but also versus Pepsi? The results were strongly positive for the new formula, even among Pepsi drinkers. This was a clear go signal. With benet of hindsight, however, some deciencies in the research design merited concern. Research participants were not told that by picking one cola, they

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46 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo would lose the other. This proved to be a signicant distortion: Any addition to the product line would naturally be far more acceptable than completely eliminating the traditional product. While three to four new tastes were tested with almost 200,000 people, only 30,000 to 40,000 of these testers tried the specic formula for the new Coke. Research was geared more to the idea of a new, sweeter cola than that used in the nal formula. In general, a sweeter avor tends to be preferred in blind taste tests. This is particularly true with youths, the largest drinkers of sugared colas and the very group drinking more Pepsi in recent years. Interestingly, preference for sweeter tasting products tends to diminish with use.20 Consumers were asked whether they favored change as a concept, and whether they would likely drink more, less, or the same amount of Coke if there were a change. But such questions could hardly prove the depth of feelings and emotional ties to the product. Symbolic Value The symbolic value of Coke was the sleeper. Perhaps this should have been foreseen. Perhaps the marketing research should have considered this possibility and designed the research to map it and determine the strength and durability of these values that is, would they have a major effect on any substitution of a new avor? Admittedly, when we get into symbolic value and emotional involvement, any researcher is dealing with vague attitudes. But various attitudinal measures have been developed that can measure the strength or degree of emotional involvement. Herd Instinct Here we see a natural human phenomenon, the herd instinct, the tendency of people to follow an idea, a slogan, a concept, to jump on the bandwagon. At rst, acceptance of new Coke appeared to be reasonably satisfactory. But as more and more outcries were raisedfanned by the mediaabout the betrayal of the old tradition (somehow this became identied with motherhood, apple pie, and the ag), public attitudes shifted strongly against the perceived unworthy substitute. The bandwagon syndrome was fully activated. It is doubtful that by July 1985 Coca-Cola could have done anything to reverse the unfavorable tide. To wait for it to die down was fraught with dangerfor who would be brave enough to predict the durability and possible heights of such a protest movement? Could, or should, such a tide have been predicted? Perhaps not, at least regarding the full strength of the movement. Coca-Cola expected some protests. But perhaps it should have been more cautious by considering a worst-case scenario in addition to what seemed the more probable, and by being better prepared to react to such a contingency.

20

New Cola Wins Round 1, But Can It Go the Distance? Business Week, June 24, 1985, p. 48.

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Analysis 47

Pepsi, and Later Coca-Colas, International Problems

Pepsis Defeats in South America With hindsight, we can identify many of the mistakes Pepsi made. It tried to expand too quickly in Argentina and Brazil, imprudently putting all its chips on a distributor with a checkered past, instead of building up relationships slower and more carefully. It did not monitor foreign operations closely enough or soon enough to prevent rash expansion of facilities and burdensome debt accumulations by afliates. It did not listen closely enough to old distributors and their changing wants, and so lost Venezuela to Coca-Cola. Pepsi apparently did not learn from its past mistakes: For example, three times before, it had tried to enter Brazil and had failed. Why the failures? Why was it not more careful to prevent failure the next time? Finally, we can speculate that maybe Pepsi was not so bad, but rather that its major competitor was so good. Coca-Cola had slowly built up close relationships with foreign bottlers over decades. It was aggressive in defending its turf. Perhaps not the least of its strengths, at least in the lucrative Latin American markets, was a CEO who was also a Latino, could speak Spanish and share the concerns, and build on the egos of its local bottlers. In selling, this is known as a dyadic relationship, and it is discussed further in the following Information Box. After all, why cant a CEO do a selling job on a distributor and capitalize on a dyadic relationship? Coca-Colas Problems in Europe Could Coca-Cola have handled the Belgian crisis better? With hindsight, we see a awed initial reaction. Still, the rst incident of 24 schoolchildren getting ill and throwing up after drinking Coke seemed hardly a major crisis at the time. But crises

INFORMATION BOX THE DYADIC RELATIONSHIP

Sellers are now recognizing the importance of the buyer-seller interaction, a dyadic relationship. A transaction, negotiation, or relationship can often be helped by certain characteristics of the buyer and seller in the particular encounter. Research suggests that salespeople tend to be more successful if they have characteristics similar to their customers in age, size, and other demographic, social, and ethnic variables. Of course, in the selling situation, this suggests that selecting and hiring sales applicants most likely to be successful might require careful study of the characteristics of the rms customers. Turning to the Pepsi/Coke confrontation in Brazil and Venezuela, the same concepts should apply and give a decided advantage to Coca-Cola and Roberto Goizueta in inuencing government ofcials and local distributors. After all, in interacting with customers and afliates, even a CEO needs to be persuasive in presenting ideas as well as handling problems and objections. Can you think of any situations where the dyadic theory may not work?

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48 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo often start slowly with only minor indications and then mushroom to even catastrophic proportions. Eventually, hundreds of people reported real or imagined illnesses from drinking the various Coca-Cola products. The mistakes of Coca-Cola in handling the situation were (1) not taking the initial episodes seriously enough; (2) not realizing the intense involvement and skepticism of governmental ofcials, who demanded complete explanations of the cause(s) and were reluctant to lift bans; and (3) not involving Coke Chairman Douglas Ivester and other high-level executives soon enough. Allowing ten days to go by before his personal intervention was a long time for Ivester to let problems fester. Added to that, the quality-control lapses should not have been allowed to occur in the rst place. Eventually, Ivester and Coke acted aggressively in restoring Coca-Cola but lost revenues could not be fully recovered. Of interest in this environment of cola wars was Pepsis restraint in not trying to take advantage of Cokes problems. This was not altruism but fear that the whole softdrink industry would face decreased demand, so Pepsi did not want to aggravate the situation. Anyway, Pepsi saved its competitive thrusts for antitrust challenges. With its great size and market-dominance visibility in country after country, Coca-Cola was vulnerable to regulatory scrutiny and antitrust allegations, especially when stimulated by its No. 1 competitor, PepsiCo. Does this mean that it is dangerous for a rm to become too big? In certain environments, such as facing a foreign competitor in some European countries, this may well be the case. The rm then needs to tread carefully, tone down inclinations toward arrogance, and be subtle and patient in seeking acquisitions on foreign turf.

WHAT CAN BE LEARNED?

Consumer Taste is Fickle
Taste tests are commonly used in marketing research, but I have always been skeptical of their validity. Take beer, for example. I know of few peopledespite their strenuous claimswho can, in blind taste tests, unerringly identify which is which among three or four disguised brands of beer. We know that people tend to favor the sweeter in taste tests. But does this mean that a sweeter avor will always win out in the marketplace? Hardly; something else is operating with consumer preference other than the eeting essence of a tasteunless the avor difference is extreme. Brand image usually is a more powerful sales stimulant. Advertisers consistently have been more successful in cultivating a desirable image or personality for their brands, or the types of people who use them, than by such vague statements as better tasting.

Dont Tamper with Tradition

Not many rms have a hundred-year-old tradition to be concerned withor even twenty-ve years, or ten years. Most products have much shorter life cycles. No

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What Can Be Learned? 49

other product has been so widely used and so deeply entrenched in societal values and culture as Coke. The psychological components of the great Coke protest make interesting speculation. Perhaps in an era of rapid change, many people wish to hang on to the one symbol of security or constancy in their liveseven if its only the traditional Coke avor. Perhaps many people found this protest to be an interesting way to escape the humdrum, by making waves in a rather harmless way, in the process of seeing if a big corporation might be forced to cry uncle. One is left to wonder how many consumers would even have been aware of any change in avor had the new formula been quietly introduced without fanfare. But, of course, the advertising siren call of New would have been muted. So, do we dare tamper with tradition? In Cokes case the answer is probably not, unless done very quietly, but then Coke is unique.

Dont Try to Fix Something That Isnt Broken

Conventional wisdom may advocate that changes are best made in response to problems, that when things are going smoothly the success pattern or strategy should not be tampered with. Perhaps. But perhaps not. Actually, things were not going all that well for Coke by early 1985. Market share had steadily been lost to Pepsi for some years. So it was certainly worth considering a change, and the obvious one was a different avor. I do not subscribe to the philosophy of dont rock the boat. But Coke had another option.

Dont Burn Your Bridges

Coke could have introduced the new Coke but kept the old one. Goizueta was concerned about dealer resentment at having to stock an additional product in the same limited space. Furthermore, he feared Pepsi emerging as the No. 1 soft drink due to two competing Cokes. This rationale was awed, as events soon proved.

Consider the Power of the Media

Press and broadcast media are powerful inuencers of public opinion. With new Coke, the media exacerbated the herd instinct by publicizing the protests. News seems to be spiciest when someone or something can be criticized or found wanting. We saw this fanning of protests in Cokes contamination problems in Europe, to the extent that some people came up with psychosomatic illnesses after drinking Coca-Cola products. The power of the media should not only be recognized but also be a factor in making decisions that may affect an organizations public image.

International Growth Requires Tight Controls

In Pepsis problems with Baesa, we saw the risks of placing too much trust in a distributor. One could question the selection of Charles Beach to spearhead the Pepsi invasion of Coke strongholds in South America. Prudence would dictate

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50 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo close monitoring of plans and performance, with major changesin expansion planning, marketing strategy, nancial commitmentsapproved by corporate headquarters. In international dealings, the tendency is rather to loosen controls due to the distances, different customs and bureaucratic procedures, and unfamiliar cultures. We will see an extreme example of this later in the Maytag case.

The Human Factor May Be More Important in International Dealings

Rapport with associates and customers may be even more important in the international environment than domestically. The distances involved usually necessitate more decentralization and, therefore, more autonomy. If condence and trust in foreign associates are misplaced, serious problems can result. Customers and afliates may need a closer relationship with corporate management if they are not to be wooed away. Furthermore, in some countries the political climate is such that the major people in power must be catered to by the large rm wanting to do business in that country.

Sound Crisis Management Requires Prompt Attention by Top Management

The chief executive is an expediter and a public relations gure in crises, particularly in foreign environments. Ivesters delay in rushing to Belgium may have held up resolution of the crisis for several weeks, and it cost Coca-Cola millions in lost revenues. No other person is as well suited as the CEO to handle serious crises. Some sensitive foreign ofcials see an affront to their country without top management involvement and are likely to express their displeasure in regulatory delays, calls for more investigations, and bad publicity toward a foreign rm. In the case of Coca-Cola, even though Ivester eventually made a conciliatory appearance, by that time some countries were receptive to antitrust allegations made by Pepsi against Coca-Cola.

Beware of High-Margin Insistence to the Neglect of Other Worthy Products

It is natural for executives to want to push the higher margin goods. After all, profitability deserves priority, everything else being equal. But often, lower margin goods may yield more total prots because of greater sales volume. Similarly, raising prices will produce higher margin per item, but lower volume may adversely affect total prots. In recent years, Coca-Cola hurt itself by concentrating on the higher margin cola drinks, to the neglect of other growth opportunities, and by injudiciously raising prices of its concentrate to bottlers, thus jeopardizing bottler relations.

CONSIDER
Can you think of other learning insights?

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What Can Be Learned? 51

QUESTIONS
1. In the new Coke asco, how could Coca-Colas marketing research have been improved? Be a specic as you can. 2. When a rm faces a negative pressas Coca-Cola did with the new Coke, and almost 15 years later in Europewhat recourse does a rm have? Support your conclusions. 3. If its not broken, dont x it. Evaluate this statement. 4. Do you think Coca-Cola engineered the whole scenario with the new Coke, including fanning initial protests, in order to get a bonanza of free publicity? Defend your position. 5. Critique Pepsis handling of Baesa. Could it have prevented the South American disaster? If so, how? 6. With hindsight, how might Enrico, CEO of PepsiCo, have kept Cisneros, his principal bottler in Venezuela, in the fold instead of defecting to Coke? 7. How could Coca-Cola have lessened the chances of antitrust and regulatory scrutiny in Europe? 8. Do you think Pepsi can ever make big inroads in Cokes market share in Europe? Why or why not? 9. A big stockholder complains, All this fuss over a few kids getting sick to their stomach. The media have blown this all out of proportion. Discuss. 10. Do you think Coca-Cola is still a growth company? Why or why not? Defend your reasoning.

HANDS-ON EXERCISES
1. Assume that you are Robert Goizueta and that you are facing increased pressure in early July 1985 to abandon the new Coke and bring back the old formula. However, your latest marketing research suggests that only a small group of agitators are making all the fuss. Evaluate your options and support your recommendations to the board. (Do not be swayed by what actually happenedmaybe the protests could have been contained.) 2. As a market analyst for PepsiCo, you have been asked to present recommendations to CEO Roger Enrico and the executive board, for the invasion of Brazils soft-drink market. The major bottler, Baesa, is already in place and waiting for Pepsis nal plans and objectives. You are to design a planning blueprint for the invasion, complete with an estimated timetable. 3. You are a staff assistant to Ivester. It is 1998, and he has just assumed the top executive job with Coca-Cola. One of his rst major decisions concerns raising soft-drink prices over 7 percent to improve operating margins and make up for diminished revenues in a depressed European market. He wants you to provide pro and con information on this important decision.

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52 Chapter 3: Cola Wars: Coca-Cola vs. PepsiCo

TEAM-DEBATE EXERCISES
1. Debate the issue of whether Coke is in a mature stage of the life cycle or whether it is still in a growth stage. In the course of the debate, each side should consider how best to maximize its performance. 2. Debate Ivesters plan to distribute millions of free bottles of Coke products to people in Belgium and Poland. In particular, debate the costs versus benets of this recovery strategy. Are the benets likely to be worth the substantial cost?

INVITATION TO RESEARCH
What are the newest developments in the Cola wars? Has Coke lost market share in Europe? Has Pepsi been able to make any inroads in Latin America? How do the two rms stack up in protability? Have there been any innovations in this arena? How has the bottled water battleground gone for the two rivals? How are their stock prices faring?